Here’s how the climate tech funding environment is shifting amid a broader VC pullback

With the white-hot investment activity of 2021 beginning to cool off, the fundraising environment now looks a little different for the startups working to cool the planet.

While climate-tech startups raised more in the first six months of this year than they did in the first half of 2021, funding has slowed down in comparison to the record-breaking second half of last year. The sector saw $18.6 billion invested across ~500 VC deals in the first half of this year, which is up 16% from H1 2021 but down 21% from H2 2021, according to analysis from Climate Tech VC (CTVC). Compared to H1 2021, overall venture funding for the first half of 2022 fell 11%, from $317 billion to $282 billion, and it fell 21% compared to the last six months of 2021, per Crunchbase.

Although climate-tech funding may not reach last year’s high of nearly $40 billion, CTVC expects deal activity to increase—and VCs are sitting on a lot of dry powder. In other words: While 2021 was “undeniably the peak” for climate-tech funding, “that doesn’t mean we’re just going to fall off a cliff,” Kim Zou, co-founder of CTVC, told us.

Even so, VCs and analysts told us there are shifts happening in the market, as investors gain more leverage and look to make smaller investments in companies with longer time horizons and strong fundamentals while pulling back from massive, later-stage investments.

Mega slump

The slowdown in climate-tech funding in the first half of 2022 can be attributed to a drop-off in one specific segment: mega-deals, or funding rounds greater than $500 million, Sophie Purdom, co-founder of CTVC, told Emerging Tech Brew. While these massive raises accounted for ~10% of climate-tech VC deals in 2021, they made up just ~2% of all deals in H1 2022, according to CTVC.

This trend mostly affects growth-stage and late-stage companies, Purdom said, while “the rest of the activity is actually sitting pretty—and growing.”

The climate-tech deal count for H1 2022 is up 76% from the first half of last year. That’s due to a surge in early-stage rounds—seed and Series A deals and funding more than doubled in the first six months of this year compared with H1 2021, according to CTVC.

This indicates that there are still plenty of opportunities to build new businesses in climate tech, Zou said.

While transportation, energy, and food have dominated funding in the sector over the last two years, more nascent climate technologies are now capturing an increased share of VC deals. In 2021, 90% of funding went to those three sectors, but in the first half of this year they accounted for about 70%, Zou said.

For example, carbon-focused startups got a huge boost in H1. The carbon vertical—which CTVC defines as everything from carbon removal to offset verification—has received 8% of climate-tech funding so far, compared with less than 2% in 2021.

The funding spike was driven by several very large deals, such as a $650 million round for Climeworks, as well as significant corporate commitments—namely Frontier—that signaled stronger demand for carbon removal, Zou and Purdom said.

And despite concerns over the larger economic trends, climate-focused VCs have still raised a lot of money. Over the last 18 months, ~$37 billion in new climate-tech funding has been announced across 72 climate venture funds and six growth funds, according to CTVC. That dry powder is probably enough to fund top-performing companies in the space for the next year or more, Purdom said.

The belt still tightens

This is still likely to be a winnowing period in climate tech.

“There’s a flight to quality happening,” Purdom said. “Now a bit more power is in the hands of investors.”

Climate startups with profits or solid customer bases could see valuation growth even as it becomes more difficult for less-proven founders to raise money, investors told us.

“Especially in a down market, it’s very hard to raise on narrative. So you really need to be able to raise on numbers and show that you have traction with what you’re building,” Johan Schwind, managing director at VC firm Urban-X, told Emerging Tech Brew.

More mature, consumer-facing sectors like food and transportation will likely continue to attract first-time climate investors, while newer, riskier tech will require more experienced investors, Zou said.

“That’s healthy, you would want that to be the case,” Purdom said, adding that she expects even more specialized funds like Lower Carbon or Counteract to be announced.

Ultimately, Zou and Purdom said, there are several reasons for continuing investor interest in climate tech despite the broader VC pullback. For one, there's an intersection between climate issues and current macroeconomic challenges like supply-chain and energy resilience. There’s also increasing urgency around climate impacts, which appears to be drawing more talent into the sector.

But the success or failure of climate tech will be determined on a different timescale than many investors have been accustomed to.

“This is a long-term, potentially multi-generational challenge. The capital model needs to support that or recognize that,” Schwind said.